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Portugal: Staff Concluding Statement of the 2017 Article IV Mission

June 30, 2017

A Concluding Statement describes the preliminary findings of IMF staff at the end of an official staff visit (or ‘mission’), in most cases to a member country. Missions are undertaken as part of regular (usually annual) consultations under Article IV of the IMF's Articles of Agreement, in the context of a request to use IMF resources (borrow from the IMF), as part of discussions of staff monitored programs, or as part of other staff monitoring of economic developments.

The authorities have consented to the publication of this statement. The views expressed in this statement are those of the IMF staff and do not necessarily represent the views of the IMF’s Executive Board. Based on the preliminary findings of this mission, staff will prepare a report that, subject to management approval, will be presented to the IMF Executive Board for discussion and decision.

An International Monetary Fund (IMF) mission visited Lisbon during June
19—29, 2017, for the 2017 Article IV consultation.

At the end of the visit, the mission issued the following statement:

Portugal’s near-term outlook has strengthened considerably, supported
by a pick-up in investment and continued growth in exports, as the
recovery in the euro area has gained momentum. Portugal has also made
commendable progress in addressing near-term risks. The strong 2016
fiscal outturn has allowed Portugal to exit the Excessive Deficit
Procedure, while the 2017 fiscal deficit target also appears well
within reach. There has also been notable progress over the past year
to stabilize the banking system, although addressing banks’ large stock
of non-performing loans and dealing with the substantial corporate debt
overhang remain medium-term challenges. Progress on these fronts would
facilitate more effective intermediation of financing to broad-based
private investment, which is essential to support strong growth over
the medium-term. Sustained strong growth, together with continued
public debt reduction, would reduce vulnerabilities arising from high
indebtedness, particularly when monetary accommodation is reduced.

Economic activity has gained momentum in 2017, supported by
continued strong growth in tourism and related construction.
Tourism revenues appear on track for a fourth consecutive year of
near double-digit growth, while investment in the sector has
supported a marked rebound in the construction sector in the first
half of 2017. There are also signs of a broad-based pickup in
exports, boosted by the robust euro area recovery. Meanwhile,
domestic confidence indicators have strengthened significantly and
employment continues to rise. House prices have also experienced
further increases in 2017, supported in part by non-resident real
estate investment. As a result, real GDP growth is projected to
accelerate to around 2.5 percent in 2017 and remain at 2 percent in
2018.

Portugal has also made commendable progress over the past year
in addressing near-term risks.
The 2016 fiscal outturn was significantly better than expected,
reflecting strong efforts to contain spending. This allowed
Portugal to exit the Excessive Deficit Procedure that had been in
place since 2009. Stability and confidence in the banking system
has also improved markedly over the past year, including through
the public recapitalization of Caixa Geral de Depósitos and the
ongoing sale of Novo Banco. Meanwhile, BCP has received a large
capital injection and BPI has been taken over by Spain’s CaixaBank.
Improved market sentiment toward Portugal has contributed to a
sharp narrowing in sovereign debt spreads since mid-March.

The pickup in growth implies that this year’s headline fiscal
deficit target of 1.5 percent of GDP is well within reach.
Stronger growth, together with the authorities’ strong commitment
to contain spending, should allow the headline deficit to be
achieved comfortably. The favorable cyclical conditions provide an
auspicious opportunity for a more ambitious reduction of public
debt this year, in support of the authorities’ medium-term targets
set in the Stability Program. Durable structural fiscal
consolidation remains essential to ensure the sustainability of
public finances, with the financing environment likely to be less
benign as monetary accommodation is eventually reduced. An
adjustment focused on reform to improve public spending efficiency
would likely be more growth-friendly and help reinforce investors’
perceptions of the predictability of the tax regime over the
investment horizon.

In addition to the recent increases in capital, Portuguese
banks are liquid and continue to make progress on deleveraging.
Nevertheless, they face numerous challenges, including low asset
quality, weak profitability and limited capital buffers. The
outstanding stock of non-performing loans (NPLs) declined by 0.3
percentage points in 2016 to 17.2 percent of total loans under the
European Banking Authority definition, with the weakness in asset
quality particularly concentrated in the corporate sector. Banks
have reduced operational costs, but this has been insufficient to
offset the drag on profitability from low interest margins and
higher loan loss impairments.

Ambitious efforts are needed by banks to strengthen their
balance sheets, which would improve financial intermediation
and help raise potential growth.
Recent steps to raise capital need to be accompanied by a
comprehensive cleanup of banks’ balance sheets and reduction in
corporate debt. This should include a credible and time-bound plan
for efforts across banks to write-off, restructure or sell
non-performing assets. The NPL enhanced coordination platform being
developed by banks with the support of the authorities is an
important initiative that could facilitate banks’ efforts in this
regard. These efforts will need to be supported by strengthening
banks’ business models and improving profitability, including
through further cost-cutting. Banks will also need to implement the
new provisioning standards and build additional buffers.

Raising the economy’s growth potential will also require
further structural reforms to boost investment and
productivity.
Ongoing initiatives along a number of fronts could help in this
regard. The recent growth in investment has been in part financed
through internal sources of funding by corporates. However,
investment levels would need to increase substantially to raise the
economy’s medium-term growth potential. This would require a more
flexible labor market where wage increases are aligned with
productivity, allowing Portugal to take advantage of higher-skilled
entrants to the labor force while safeguarding competitiveness.
Structural reforms should also focus on the bottlenecks that
continue to influence investors’ perceptions of the business
environment, including inefficient judicial processes and the
complexity of regulations governing the operation of enterprises.

The mission would like to express its gratitude to the Portuguese
authorities and other interlocutors for a close and constructive
dialogue.